Friends, family and fools - Page 2

Doing business with FFFs can also inhibit your business in certain ways. You might well have to settle for a lesser amount than a professional investor could offer, or jeopardise your family member's financial security by asking for money you know they can't afford to lose.

One of the huge advantages of a VC or angel is they, typically, have the expertise and contacts needed to take your business to the next level, fast. Your Great Uncle Alvin might not have quite the same credentials.

"When it came to doing our first institutional round we were not very well prepared for it. And then we had to invest a lot of time and energy into getting everything in order."

That's not to say you can't bring in commercial investors later on. Although you might find things more complicated when you do. Sokratis Papafloratos sold equity in his recommendations site TrustedPlaces to two friends, with terms written up in a one-page document he had put together himself. Now, he says, he would advise people in a similar situation to get a solicitor in. "It just adds another layer of quality to the whole process and it makes future investment you're going to get that little bit easier. When it came to doing our first institutional round we were not very well prepared for it. And then we had to invest a lot of time and energy into getting everything in order."

Bear in mind that if you bring in a bank they will almost certainly want first rank in security - meaning that if your business fails, they will get any pay-out before your FFFs.

The six-step solution

Don't let all that put you off though - provided you do things by the book, you can avoid the vast majority of problems further down the line. Here's our six-step plan to make sure everyone walks away happy, whatever happens.

1. Avoid asking anyone you suspect can't afford it.

2. Make sure they know the risks.

3. Agree the structure of the deal and treat them fairly.

Richard Ellis, a partner at accountancy firm Ellis Lloyd Jones LLP that specialises in startup accountancy, says the most straightforward way to lend money from a tax point of view is via a loan, without interest. Charging interest can 'become a bit complicated', and would require the lender to start filling out a self-assessment tax return. That said, the person lending you the money might not be too keen to loan to you without charging interest. Plus, if the company really takes off, they're only ever going to get the original amount they put in back, give or take interest.

The other option is to sell your FFF shares, allowing them a slice of the pie if you make it big time. The risk is that if the business fails they're very last in line to be repaid anything. From your point of view, shares can also be sticky as it gives the FFF ownership in the company, a voice in how it's run.

4. Write it all down.

"It can help preserve the relationship if you can let the document be the bad cop," explains Ross Bryson, partner in the corporate department at Mishcon de Reya. "Then it's written down, rather than: 'Well I though you told me in the pub XYZ'." Bryson advises 'approaching the whole thing on an arm's length basis', and offering security and rights as you would a professional investor.

5. Make it legal.

This is usually more important when dealing with friends than with, say, your parents, but getting professional legal advice never hurts. It doesn't have to be expensive - there are plenty of startup-friendly firms out there these days who'll advise you for free or for next to nothing on the promise of more work further down the line if things take off. But it does mean everyone will know what's going on, you'll all be treated fairly and, if something awful does happen, you'll have a document that can stand up in court - as most home-made versions don't.

Bryson says if people try to draw up their own document 'they just won't think of all the issues'.

6. Make ground notes.

Figure out at this early stage how you'll report progress to the FFF. Consider when you'll provide updates and what detail they'll give.

You also, of course, need to have worked out repayment or dividend terms by this stage - remember to factor in any grace periods on payment deadlines.

Finally, but crucially, talk out what happens in case of emergency - if the business fails, if it needs a serious cash injection, or any other fateful possibility that you or your solicitor points out.

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If you make sure you do all that, you may well land yourself some pretty fantastic funding - with the added bonus of sharing your business with some of the most important people in your life. Which really isn't too bad an idea at all.

Heather Wilkinson is a Make Your Mark ambassador, the business backed national campaign to increase entrepreneurial behaviour amongst young people. Visit www.makeyourmark.org.uk.

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